The banking crisis is basically what spawned a whole new way of lending that cuts out the middleman and bypasses the bankers. Peer to peer lending works on the basis of matching investors who are looking to earn interest by lending to individual investors.

This is done through one of the many lending platforms that are now in existence and thriving, such as Lending Club, Zopa, Ratesetter and Landbay and hundred of other similar sites that work on a similar model to dating sites in many ways, by matching people according to their suitability, although money is the motivation rather than love of course.

Financial matchmaking

Peer to peer lending is financial matchmaking and is a simple format in many ways, working to match investors who are looking to lend some of their cash to consumers or companies who want a better rate for their loan and also might not be able to get a  loan from their bank.

Credit scoring

Bank lending criteria tightened considerably in the aftermath of the banking crisis in 2008 and this meant that people of business who were looking for a loan, were often unable to get the money they needed.

Peer to peer lending has helped to produce this required liquidity in lending markets, but the same principles and requirements apply for someone to qualify for a loan, as they will need to still pass a credit check and prove they can afford to repay the money they are borrowing.

This is part of the job that sites like Lending Club do as part of their service. They match up investors looking to lend money with suitable borrowers, and then do all the necessary checks such as credit scoring and identity checks.

Controlling risk

If you are considering peer to peer lending as an alternative investment and want to lend out some money in order to get a better interest rate than if you left it in savings, you also need to understand the risks attached to the venture.

You should expect the lending platform to screen borrowers and place them into a specific risk category based on their credit score and past payment performance.

If you take Lending Club as an example, only between 10-20% of applicants get approved and are able to request a loan in the marketplace. Each borrower is also categorized using a number of factors and those with the highest credit ranking can borrow at a lower rate of interest to borrowers who are perceived to have a higher risk of defaulting.

As a lender, you can choose which level of risk you want to lend to. If you want a more safe and steady return on your investment, you might choose to only lend to higher grade borrowers and accept a lower rate of interest return on your money. Alternatively, you might decide to seek a higher rate of return on the understanding that you are lending to a higher risk borrower, albeit one that has passed a credit scoring process.

Tax implications

You will need to clarify the tax position depending on which country you are based in. In the UK, the interest you earn on your money is subject to tax in the same way as normal savings.

You may not be able to claim any tax relief for bad debts, but you will be expected to pay tax on all interest you are paid, which will be a lower figure anyway if one of your loans goes bad.

Bad debts

Although peer to peer lending is the same as any other type of loan and bad debts do occur, there are some platforms who offer some guarantees against bad debts.

In the UK, Zopa offers an interest rate that is guaranteed for 3 or 5 years and will be paid to you regardless of whether there are any loans involving your money that are in default.

Peer to peer lending often involves spreading the risk amongst a number of borrowers, so the money you lend through the scheme could be split amongst 100 or more borrowers, which helps to reduce the impact felt when one of the loans is not repaid.

Lending categories

You can choose to lend through certain sites which specialize in certain types of loans if you have a particular preference.

Landbay matches your money to a portfolio of UK residential mortgages with a view to generating a regular rental income . You might also decide that you want to lend your money to businesses through a site like Funding Circle or like the idea of consumer loans.

With peer to peer lending you can choose a range of lending categories and choose a level of risk that you are comfortable with and it can be a form of alternative investment that will potentially generate a positive return on your money